What Is a Parity Bond?
A parity bond refers to two or more bond issues with equal rights of payment or equal seniority to one another. In other words, a parity bond is an issued bond with equal rights to a claim as other bonds already issued. For example, unsecured bonds have equal rights in that coupons may be claimed without any particular bond having priority over another. Therefore, unsecured bonds would be referred to as parity bonds with each other. Similarly, secured bonds are parity bonds with other secured bonds.
A parity bond is also referred to as a pari passu bond or a side-by-side bond.
- Parity bonds are sets of debt instruments that all have equal rights, payment, and/or equivalent seniority.
- Parity bonds come into play most often during bankruptcy proceedings or in the event of default.
- Unsecured bonds from the same issuer are an example of parity bonds since no one bond would have priority over another.
Understanding Parity Bonds
Parity bonds are similar to pari passu securities, which are securities or debts which have equal claims on a right without any display of preference. The term “pari passu” comes from Latin, and means equal footing. For example, in a pari passu security, holders of common shares all have equal rights to claim a dividend without one shareholder having priority over another.
A series of fixed-income securities may be issued as a parity bond, or include a pari passu clause, in order to establish that it functions in the same way as previously issued bonds.
Since an asset backs secured debts, they are often not fully equal to the other obligations held by the borrower. Since there is no asset supporting unsecured debts, there are greater instances of borrower default or bankruptcy. Further, a provider of unsecured financing may enact clauses that prevent a borrower from taking part in certain activities, such as the promising of assets for another debt to keep a position with regard to repayment.
Unsecured debts will have parity with respect to other unsecured debts, meaning that the bonds have equal rights over the coupon. Secured debts will also have parity with respect to other secured debts, although secured debts will have rights that supersede those of unsecured debts. In other words, guaranteed debts and unsecured debts are not parity bonds concerning each other.
Example of a Parity Bond
Parity bonds have equal rights to the coupon or nominal yield. In fixed-income investments, the coupon is the annual interest rate paid on a bond. Consider a $1,000 bond with a 7 percent coupon rate. The bond will pay $70 per year. If new bonds with a 5 percent coupon are issued as parity bonds, the new bonds will pay $50 per year, but bondholders will have equal rights to the coupon.
A parity bond stands in contrast to a junior lien or senior lien bond. A junior lien bond, also called a subordinate bond, has a subordinate claim to pledged revenue as compared to a senior lien bond, which is also called a first lien bond. Unsecured debts are subordinate bonds compared to secured debts.